One announcement in the autumn statement that was not well briefed in advance was the further increase in the personal allowance. This will rise by an extra £235 in April next year, on top of the £1,100 increase already announced by the chancellor back in March; from next April, the tax-free allowance will be £9,440, edging closer to the £10,000 threshold identified in the coalition agreement and long championed by the Liberal Democrats.
Taking low earners out of income tax and lowering the tax burden on millions of workers is good politics, but very expensive. Yesterday’s announcement will see income tax bills for all but the highest earners fall by £47 a year – or just 90p a week – at a cost of £1 billion. The total cost of the higher allowance from April next year will be around £4.3 billion.
Raising the personal allowance is also a very inefficient way of helping low to middle income families. A higher personal allowance is progressive across individuals because it gives most basic rate taxpayers a flat rate amount, but this changes when we look at how different households benefit.
For this latest increase, the higher rate threshold was left unchanged, so most higher rate taxpayers will gain £47 a year alongside basic rate taxpayers. Affluent households, which are more likely to have two earners and therefore benefit twice, will gain the most. On average, today’s announcement will benefit the richest fifth of households by £78 a year, as the chart below shows.
Less well-off families are more likely to be out of work or have only one earner, and many workers in these families will earn too little to benefit from a higher tax-free allowance.
Someone working 25 hours a week on the minimum wage would earn £8,047 a year, so they will be no better off in April 2013. The average gain for the poorest fifth of households will be just £7.54 a year, so the most affluent fifth of households will see their net incomes rise by 10 times as much as the poorest fifth. Around the middle of the income scale, the average household will be better off by about half as much as the richest fifth.
The chancellor plans to use spending cuts to achieve 80 per cent of his ongoing deficit reduction, with just 20 per cent coming from higher taxes. This imbalance means the less well off will contribute more to deficit reduction than the better off, since they rely more heavily on benefits and public services.
Yesterday’s commitment on the personal allowance means taxes will take a smaller share of the deficit reduction burden than they otherwise would. In the long-term, regular above-inflation increases in the personal allowance erode the UK’s tax base when ageing and rising prosperity are driving up demand for public spending, suggesting a need to at least maintain revenues in the long-run.
A better use of £4 billion would be to invest in areas likely to boost jobs and growth over the long-term. A prime candidate is affordable childcare, which is credited with helping sustain high levels of employment in dynamic economies like Sweden and Denmark, particularly among mothers. The coalition has made new commitments on childcare recently but these have been fairly small-scale, like £2 million for start-up grants for new nurseries.
Given the high cost of childcare to British parents, investment on a much greater scale is required. Extending free childcare to 25 hours a week for all children aged one to four would cost around £3.7 billion, or less if parents were asked to make a small contribution.
Given the benefits of high-quality, affordable childcare for parents and children, not to mention the economy, this would be a better long-term investment than a tax cut.